Credit life insurance in South Africa: the customer’s ...

Credit life insurance in South Africa: the customer's perspective

By Nina Shand with Janice Angove for FinMark Trust December 2013

Table of Contents

List of Abbreviations and Acronyms..........................................................................................iii 1. Introduction........................................................................................................................4 2. What is credit life insurance? .............................................................................................5

2.1. Features ......................................................................................................................5 2.2. Models ........................................................................................................................6 2.3. Value proposition .......................................................................................................7 3. The regulatory environment for credit life insurance in South Africa ...............................9 3.1. Regulatory bodies.......................................................................................................9 3.2. Main regulatory provisions.........................................................................................9 4. South African market for credit and credit life insurance ............................................... 12 4.1. Overview.................................................................................................................. 12

4.1.1. Size and composition....................................................................................... 12 4.1.2. Products and providers ................................................................................... 13 5. Does the credit life insurance market work for consumers? .......................................... 15 5.1. Supply-side perspective........................................................................................... 15 5.1.1. Interviews with industry bodies and credit life insurance providers .............. 15 5.1.2. Interviews with ombuds .................................................................................. 16 5.2. Demand-side perspective........................................................................................ 17 5.2.1. Methodology ................................................................................................... 17 5.2.2. Key findings...................................................................................................... 19 5.3. Data perspective...................................................................................................... 28 5.3.1. Cost of credit life insurance............................................................................. 28 5.3.2. Claims and expense ratios ............................................................................... 30 6. Conclusion ....................................................................................................................... 32 7. Appendix A: International examples ............................................................................... 34 7.1. Australia................................................................................................................... 34 7.2. United Kingdom....................................................................................................... 36 8. Appendix B: Overview of legislation relevant to credit life insurance in South Africa.... 38 8.1. National Credit Act, 34 of 2005 ............................................................................... 38 8.1.1. NCA provisions................................................................................................. 38 8.2. Insurance legislation................................................................................................ 40 8.3. Industry guidelines .................................................................................................. 41 8.4. Planned legislation .................................................................................................. 42 9. Appendix C: Overview of main credit providers in the credit life space ......................... 43 9.1. Furniture retailers.................................................................................................... 43 9.2. Unsecured/personal loan providers........................................................................ 46 9.2.1. African Bank..................................................................................................... 47 9.2.2. Capitec Bank .................................................................................................... 47 9.2.3. Other micro lenders......................................................................................... 48 10. Appendix D: Mystery shopping and consumer interview methodology..................... 49 11. Appendix E: Issues raised by credit life insurance providers ...................................... 52

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11.1. Issues raised by providers and industry bodies................................................... 52 11.1.1. Regulation........................................................................................................ 52 11.1.2. The marketplace .............................................................................................. 52 11.1.3. Credit bureaux ................................................................................................. 53

11.2. Issues raised by the two ombuds ........................................................................ 53 12. Appendix F: Snapshots of quotations.......................................................................... 54 13. References ......................................................................................................................2 List of tables Table 1. Overview of credit life insurance models .....................................................................7 Table 2: Credit life insurance complaints categorised by nature of complaint (2012) ........... 17 Table 3: Credit check and affordability assessment ................................................................ 20 Table 4: Comparison between 3 major furniture retailers (see Appendix F for originals)...... 22 Table 5: Comparison between 3 microloan providers for loans to the value of R2 000......... 23 Table 6: Credit life specific questions ...................................................................................... 24 Table 7: Current premium rates relative to proposed maximum rates. ................................. 29 Table 8: Claims and expense experience for credit life business for South African insurers.. 30 Table 9: Product disclosure recommendations from ASIC review of Australian CCI market.. 35 Table 10: Loan comparison for 5 providers............................................................................. 48 Table 11: Comparison of 5 credit life policies ......................................................................... 48 List of boxes Box 1: Trends in uptake of credit and insurance..................................................................... 13 Box 2: Retail furniture credit pricing ....................................................................................... 14

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List of Abbreviations and Acronyms

ABIL

African Bank Investments Limited

AEC

Adverse Effect on Competition

AEDO

Authenticate Early Debit Order

ASIC

Australian Securities and Investment Commission

ASISA

Association of Saving and Investment South Africa

CBA

Credit Bureau Act

CCI

Consumer Credit Insurance

CPA

Credit Protection Act

FAIS

Financial Advisory and Intermediary Services Act

FSB

Financial Services Board

JDG

JD Group

LTIA

Long Term Insurance Act

MFRC

Microfinance Regulatory Council

NCA

National Credit Act, 2005

NCR

National Credit Regulator

NLR

National Loans Register

OFT

Office of Fair Trading

PPI

Payment Protection Insurance

SAIA

South African Insurance Association

SAM

Solvency Assessment and Management Act

StanGen

Standard General Insurance Company Limited

STIA

Short Term Insurance Act

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1. Introduction1

Credit life insurance is one of the most widely available insurance products to low-income consumers world-wide and is often a low-income consumer's first encounter with insurance. Therefore the question of whether consumers are getting a fair deal when they purchase it is central to the inclusive insurance debate. This paper analyses the question through the lens of the low-income consumer in South Africa.

The research in this paper follows an independent panel of enquiry, known as the Nienaber panel, to "identify and eradicate undesirable practices prevalent in the consumer credit insurance market impacting negatively on consumers"2. The panel report, released in 2008, found that while consumer credit insurance (CCI) fulfilled a definite insurance need, it is in the first instance designed to serve the interests of the credit provider and that there were deficiencies in the system that could be exploited by unscrupulous providers. It found that CCI has a bad name ? and not only in SA ? and that this perception may relate to various factors, including a lack of proper disclosure. However, the panel cautioned that CCI comes in a variety of forms and is issued by a variety of insurers, making generalisation difficult.

In 2011, government formed a Consumer Credit Insurance Task Team, jointly led by National Treasury and the Financial Services Board, to investigate the state of the consumer credit insurance industry in South Africa. The current study complements the work of the Task Team in that it offers a demand-side perspective on how consumers experience the purchase of credit life insurance, particularly in the low income space, as per FinMark Trust's focus (using LSM 1-73 as a proxy indicator for the low-income market).

Note that this study focuses specifically on credit life insurance ? insurance taken out by a consumer to cover a debt they have incurred in the event of death, disability or retrenchment, often at the insistence of the credit provider as a form of collateral security. The Task Team, as did the Nienaber panel, focuses on consumer credit insurance, a broader term referring to both credit life insurance and asset protection insurance on goods bought on credit.

The main methodology for the study is a mystery shopping exercise focused on a broad range of furniture retail and microfinance outlets operating in the LSM 1-7 space.4 In addition, in-depth interviews were conducted with low income consumers who had entered into a credit agreement or taken out a micro-loan. The questions focussed on the whole process of purchasing credit life insurance, beginning with the application for credit, in an attempt to see at what point in the process and in what manner credit life is being sold. In

1 At the time of publication the exchange rate between the South African Rand and the United States Dollar and Great British Pound was ZAR 10.36/USD and ZAR17.02/GBP respectively. USD and GBP equivalents shown throughout this document were converted at this rate. 2 A Report by the Panel of Enquiry on Consumer Credit Insurance in South Africa, p1. 3 "LSM (Living Standards Measure) refers to the most widely used marketing research tool in Southern Africa, cutting across race, gender and other traditional marketing segments to focus instead on how one lives, taking into account one's general living standards and access to amenities. It divides the population into 10 LSM groups, 10 (highest) to 1 (lowest). Lower-income products would generally be targeted at categories 2 through 6 (as those in category 1 would have no disposable income), although 7 is also relevant in the context of promoting financial inclusion. 4 Credit life insurance sold through these outlets was the focus of this study because these were the most likely to target the lower-income segment. Exploring the retail clothing sector could be considered for a follow-up study.

effect, the purpose was to establish the way in which sales staff on the ground is complying with legislation and how this is impacting on the consumer experience of credit life insurance.

The rest of this paper is structured as follows:

Section 2 provides an overview of credit life insurance models and the value proposition thereof.

Section 3 outlines the regulatory environment for credit life insurance in South Africa, Section 4 provides an overview of the South African credit life insurance market. Section 5 outlines the findings of the study as emerged from the mystery shopping

exercise and consumer interviews. In addition, data analysis is conducted to highlight trends in claims and expense ratios. The report concludes with emerging issues in Section 6.

2. What is credit life insurance?

2.1. Features

According to the National Credit Act (NCA): "'credit life insurance' includes cover payable in the event of a consumer's death, disability, terminal illness, unemployment, or other insurable risk that is likely to impair the consumer's ability to earn an income or meet the obligations under a credit agreement."5 A credit provider is entitled to require a consumer to maintain credit life insurance during the time of the agreement so that the loan will be paid should something happen to the customer. The pay-out decreases in correlation to the repayment making it a decreasing sum assured product. It is designed to protect and provide a measure of security for both the insured and the credit provider. It also provides an additional source of income for the lender from the insurance sale.

Depending on how the product is structured, it can consist purely of a life insurance component or be structured as a "hybrid" product with life and general insurance components.

The life insurance component is typically structured as follows:

Policies will pay a lump sum equal to the value of the outstanding debt in terms of a credit agreement in the event of the death of the assured life or their permanent disability.

Policies also typically offer a benefit covering either a proportion of the outstanding debt, or a benefit that covers a proportion of your monthly instalment (up to 100%) for a specified period of time (sometimes as little as three months). Pay-outs are made in the event of the insured becoming temporarily disabled, retrenchment occurring, is placed

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on short time that leads to a 20% reduction or more on the monthly basic income, or for compulsory unpaid leave.

Credit life insurance can also include dread disease cover where the consumer is covered for an amount equal to the death benefit if they are diagnosed with a dread disease such as renal failure, paraplegia, heart attacks or loss of speech, amongst others.

Typical terms and conditions that apply include:

Retrenchment benefits are not paid if a person is self-employed or is retrenched within 30 days of the commencement of the insurance cover (in some cases, waiting periods are up to 3 months).

In cases where the cover is towards monthly credit instalments, such instalments are paid to the credit provider for a maximum of 12 months (although some insurers pay the full amount owing by the assured).

Credit life insurance is often not underwritten at the point of sale. In other words, the insurer does not ask any health specific questions at the application stage.

Pre-existing conditions are limited to 24 months preceding the policy inception and these conditions are only excluded for 12 months post policy inception (as per the ASISA Guidelines)6.

Some insurers specify that their liability does not extend beyond a person's 65th birthday.

Sometimes credit life insurance is combined with asset protection cover which typically provides cover for accidental damage or destruction of goods, fire or theft from the premises, as well as riot cover. In terms of the NCA, credit providers may insist on both credit life insurance as well as product protection insurance. Product protection insurance claims must be submitted within 30 days if the asset is stolen or destroyed or damaged. The insured is then paid out for the loss and is relieved of the liability of continuing paying for an asset which they no longer have access to.7

2.2. Models

Credit life insurance can be provided in one of four ways:

Model

Credit life insurance offered by the credit provider

Description

This is the most common arrangement. The insurer is the principal and the credit provider/retailer is the agent. The credit life insurance is sold by intermediaries for commission in conjunction with the credit transaction with the intermediary often being the credit provider. This is the model most of the furniture retailers use with regards to selling credit life insurance. In the past, furniture retailers would enter into agreements with conventional insurance companies whereby the retailers would market and administer insurance

6 Association for Saving and Investment (ASISA) Credit Life Insurance Guidelines effective 01-03-2011 7 Panel of Enquiry into credit life insurance

2.3.

Cell captives

Credit provider as policyholder Self-insurance

products on behalf of the insurer concerned in return for a commission. Following a trend towards integration of the value chain, the major retailers now own their own insurance subsidiaries which provide the insurance products they need to secure their credit sales, such as credit life insurance and product insurance They also often offer additional insurance such as funeral cover which is not related to the credit sale but is a voluntary add-on.

Cell captives are a South African innovation8. Under a cell captive arrangement, an entity such as a credit provider buys a cell in a cell captive insurer (a specially licenced long-term or short-term insurer) in the form of a class of shares. This allows the cell owner to on-sell insurance to its client base without setting up an insurance company of its own or becoming a commissioned intermediary. Instead of paying premiums to an insurer, the cell captive can keep the underwriting profits and build capital in their cells. In effect, the cell owner thus "rents" or "buys" part of the cell captive insurer's licence, with the full insurance compliance burden resting on the cell captive insurer.

Under this model, the credit provider's whole book is insured by one insurer, with the credit provider, rather than individual borrowers, as policyholder.9 Thus no insurance is sold to borrowers. Instead, the credit provider pays the premium to the insurer and is the beneficiary of any claims payments.

This covers credit for which there is no insurance offered and the credit provider carries the risk of default internally, implicitly pricing for it in the interest rate.

Table 1. Overview of credit life insurance models

Value proposition

Credit life insurance protects both the credit provider and the consumer:

It protects the credit provider against default on repayments relating to the risks covered. In addition, it provides credit providers with the opportunity to earn additional fee income (commission and administration fees), allows it to avoid the need to attempt claim payment from a deceased borrower's estate, which could lead to negative public relations, and allows the lender to offer a broader set of financial products.10 These benefits have precipitated the expansion of credit life insurance and the establishment of closer links between credit providers and insurers offering this type of insurance.

8 Cell captives now constitute more than R10 billion of the country's insurance market in terms of premiums written, accounting for one sixth of all short-term insurance written. Guardrisk has an estimated 56% of the cell captive market share and have a cell captive arrangement (for example) with Thuthukani Financial Services and the Elite Group. 9 Capitec Bank is an example of this model. Channel Life covers Capitec's entire book (for loans 6 months or longer) for defaults due to death and retrenchment. There is no cover against default due to disability and government workers are not covered for retrenchment. They also have catastrophe cover for the full balance of their outstanding book. 10 J. Wipf, E. Kelly, and M. J. McCord, 2011

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